Citigroup: Earnings Winner

NEW YORK ( TheStreet) -- Citigroup ( C) was the big winner on Monday among the largest U.S. banks, with shares rising 5.5% to close at $36.66.

The broad indexes all rose 1% after the U.S. Department of Commerce announced that retail sales in September increased 1.1% from August and 5.4% from a year earlier, to an estimated $412.9 billion. While it is the smallest type of business listed among the broad categories in the Commerce Department's report, the category with the largest year-over-year improvement for sales during the first nine months of 2012 was furniture and home furnishing stores, with retail sales rising 8.8% to $70 billion. This is the latest of many indicators for a housing recovery.

The KBW Bank Index ( I:BKX) rose 1% to close at 50.50, with 16 of the 24 index components showing gains for the session.

Citigroup reported third-quarter earnings of $468 million, or 15 cents a share, declining from 95 cents during the second quarter, and $1.23 during the third quarter of 2012.

It was a messy quarter for Citi, including a $4.7 billion pre-tax loss on the company's sale of a 14% stake in the Morgan Stanley Smith Barney joint venture, and the write-down of its remaining stake in the joint venture, as well as a negative $776 million in debit valuation adjustments, as well as a $582 million tax benefit. Excluding these items, the company earned $3.3 billion, or $1.06 a share during the third quarter, beating the consensus estimate of 96 cents a share, among analysts polled by Thomson Reuters.

"We calculate this is equivalent to a return on tangible equity of 15% on core capital," said Atlantic Equities analyst Richard Staite, who rates Citigroup "Overweight" with a $44 price target. Staite was added that "key features were good net interest income growth with the net interest margin expanding 5bp plus good Investment bank results with fixed income, currency, and commodities trading up 31% QoQ." Meanwhile, the company's estimated Basel III Tier w common equity ratio "was also strong at 8.6% ahead of the 8.4% reported by JPM."

Citigroup's margin expansion was impressive, considering that most of the large banks are continuing to see margin pressure, with the Federal Reserve keeping its target federal funds rate between zero and 0.25% since the end of 2008, and the central bank in September increasing its purchases of long-term securities -- QE3 -- in an effort to hold long-term rates at their historically low levels.

Wells Fargo ( WFC) preannounced an expected significant decline in its net interest margin, although investors probably didn't expect the company's third-quarter margin by 25 basis points, which the company reported on Friday. For Wells Fargo, the margin decline was offset by efficiency improvements and continued strength in mortgage originations. The company's shares pulled back 1% on Monday, to close at $33.90.

JPMorgan Chase ( JPM) also saw its net interest margin contract. The company on Friday reported third-quarter earnings of $5.7 billion, or $1.40 a share, increasing from $5.0 billion, or $1.21 a share, during the second quarter(despite booking $4.4 billion trading losses from the widely publicized hedging activity in the company's Chief Investment Office), and $4..3 billion, or $1.02 a share, during the third quarter of 2011. The company reported third-quarter net interest income of $10.976 billion declining from $11.146 billion the previous quarter and $11.817 billion a year earlier, as the company's core net yield on interest-earning assets narrowed to 2.92% during the third quarter, from 3.00% during the second quarter, and 3.14% during the third quarter of 2011. JPM rose 2% on Monday, to close at $42.38.

Getting back to Citigroup, the company's regulatory capital kept growing, reflecting continued profits, as well as an increase in the among of deferred tax assets it was allowed to include in the capital ratio calculations, and because Citi Holdings continued to shrink, with total assets of $171 million as of Sept. 30, declining from 10% from the previous quarter, and 31% from a year earlier. Citi Holdings is the subsidiary in which run-off assets -- including Citigroup's stake in the Morgan Stanley Smith Barney joint venture -- have been place, as part of CEO Vikram Pandit's long-term strategy to exit non-core businesses, shrink the balance sheet and shore up capital.

Pandit on Monday said during the company's earnings conference call that "in the emerging markets, policy makers have been quick to act, and we expect growth there to substantially keep outpacing the developed markets. In light of these factors, we'll continue to manage our risk carefully, using the deep knowledge we have of the markets where we do business." During the third quarter, 58% of the company's revenue came from outside the United States, while 60% of net income was earned outside the U.S.

When ask to comment on the company's plan for a return of capital during 2013, in light of its strong and growing estimated Basel III Tier 1 common equity ratio, Pandit said "it's still early. We haven't even seen the scenario yet," that the Federal Reserve will use during the first quarter during its next round of stress tests," and that "as we look at that and then we'll decide what we will request from the regulators on capital."

"Obviously this is not a question of our ability to generate capital. As you know, we've shown you that," he said.

Citigroup's shares have now returned 39% year-to-date, following a 44% decline during 2011. The shares trade for 0.7 times their reported Sept. 30 tangible book value of $52.70, and for eight times the consensus 2013 EPS estimate of $4.55.

Interested in more on Citigroup? See TheStreet Ratings' report card for this stock.

Bank of America

Shares of Bank of America ( BAC) rose 3.5% to close at $9.44. The shares have now returned 70% year-to-date, following last year's 58% drop.

The shares trade for 0.7 times their reported June 30 tangible book value of $13.22, and for 10 times the consensus 2013 EPS estimate of 91 cents.

Bank of America will report its third-quarter results on Wednesday, with a consensus estimate of seven-cent loss, declining from earnings of 19 cents in the second quarter, and 56 cents during the third quarter of 2011.

Bank of America late last month announced it had agreed to pay $2.43 billion to settle a class action suit brought in 2009 by investors against the company and "certain of its officers and directors," over claims that the bank and its executives made misleading statements when the company acquired Merrill Lynch.

In addition to litigation expenses of $1.6 billion, Bank of America said its third-quarter results would be "impacted by approximately $1.9 billion (pretax) in negative fair value option (FVO) adjustments and debit valuation adjustments (DVA) related to the improvement in the company's credit spreads, and the previously reported charge of approximately $800 million to income tax expense for changes in the U.K. corporate tax rate and the related effect on the deferred tax asset valuation."

In his expanded read-through of large-bank expectations, following Friday's earnings announcements by JPMorgan Chase ( JPM) and Wells Fargo ( WFC), KBW analyst Frederick Cannon on Sunday said that "the JPM results have a positive read-across for BAC as consumer credit trends improved (after looking through the regulatory change that required the bank to charge off loans, even if they are performing, where the borrower has filed Chapter 7 bankruptcy) significantly at JPM and mortgage and investment banking both performed well, giving some upside potential to BAC's quarter."

"The upside on the read-across leads us to believe BAC will post a beat to the Street in the quarter and gives us increased confidence around our $0.15 operating estimate," Cannon said. KBW's operating EPS estimate for Bank of America excludes "the UK tax issues and the DVA loss."

Since "Investment Banking fees at JPM were up nicely (~15% QoQ), with debt underwriting being the predominate driver of the increase," KBW is "forecasting for down IB revenue at BAC in the quarter and given BAC's strong position within the debt underwriting markets there should be upside to these estimates in the $200-$300M range in the quarter."

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.